What Are Credit Scores? How Do You Improve Them?

Feb 10, 2022

9

min read

J

ust like you need to have a good SAT score to enroll in a university, you need to have a good credit score to get loans.

Credit scores are the first thing lenders consider when processing your loan application. You can easily borrow loans at attractive rates if you have a good credit score.

However, your loans will likely be rejected or restricted to high interest rates if you have bad credit scores.

Lenders usually consider credit scores to measure financial health and creditworthiness. Based on it, they categorize the client as high risk and low risk to make decisions for lending loans and charging the interest.

What Is A Credit Score?

A credit score is a grading system that grades you according to your financial ability to repay the borrowed debt. It's a quantitative measure of the creditworthiness of the borrower.

The score is a three-digit figure that usually ranges from 300 to 900, with 900 being the best. Generally, a credit score is calculated based on your credit history and credit reports.

The credit bureaus collect your credit data considering your payment history, credit usage, length of credit history, and more to determine the score.

Credit scores are one of the critical aspects that lenders consider when deciding whether to lend you the loan or not. A good credit score can give you access to a broader range of loan options and best rates.

What Is A Good Credit Score?

A good credit score means that you are financially reliable, and the lender considers you a trustworthy and low-risk borrower.

There is no exact definition of a good credit score since they vary depending on the lenders and credit rating agencies. However, a score higher than 700 is regarded as a good credit score.

If a lender approves your credit application, it might also help you qualify for lower interest rates and better terms.

However, having a good credit score doesn't guarantee that your loan application will be approved since other factors also affect your application, such as your assets, income, loan purpose, and other variables.

Credit Score Ranges

The credit score ranges vary upon the lenders and credit rating agencies as they have set their own standards. However, FICO and VantageScore are two dominant credit score brands in the United States, and each has its credit score range.

FICO Credit Score Range

FICO is the most prominent and commonly used credit score brand, with a rating range of 300 to 850.

It assists lenders in assessing the risk of a borrower defaulting on a loan. The better your score, the less risky you are to everyone who lends you money.

Exceptional credit: 800 to 850
Very Good credit: 740 or 800
Good credit: 670 to 740
Fair credit: 580 to 669
Poor credit: 300 to 580

VantageScore Credit Score Range

VantageScore, officially launched in 2003, collaborates with the three central credit reporting agencies: Equifax, TransUnion, and Experian. Although FICO Ratings are the most popular among lenders, VantageScore is also worth considering.

It employs a credit score range of 300 to 850. The better your credit score on the VantageScore scale, similar to FICO Scores, the lesser the risk you represent to lenders.

Excellent credit: 750 to 850
Good credit: 700 to 749
Fair credit: 650 to 699
Poor credit: 550 to 640
Poor credit: 300 to 540

What Affects Your Credit Score?

Payment History

Your bill-paying history carries the most significant weight regarding your credit score. It accounts for 35% of your total credit score.

If you cannot pay your credit card bills and EMI on time, it has a massive impact on your credit score.

Credit Usage

Credit Usage also has a considerable impact on your credit score. It simply refers to how much credit of the available limit has been used.

It is responsible for 30% of your credit score. Thus, if you have credit cards, maintaining a low balance-to-limit ratio (also known as credit usage ratio) may help you gain and maintain a higher credit score.

Length Of Credit History

Length of credit history means how long your credit accounts are open and active. The account age accounts for 10% of your credit score.

Long credit history is beneficial to your credit score since lenders can observe your repayment patterns over time. Thus, older accounts with a long credit history have more credit points than new accounts.

Mix Of Credit Types

Credit mix or maintaining a range of accounts might benefit your credit score slightly. You will benefit from diversity in this situation as it covers 10% of your credit score.

These outlying indicators consider whether you're effectively managing installment accounts (such as a vehicle loan, personal loan, or mortgage) and revolving accounts (such as credit cards and other credit lines).

Recent Applications

This factor considers if you've recently applied for or created new accounts. The new applications significantly influence your credit score and account for 10% of your credit score.

A hard inquiry occurs when you apply for new credit, and a lender analyzes a copy of your credit report. Hard inquiries remain on your credit record for two years and may harm your credit score.

On the other hand, recent applications can boost your credit score by increasing your credit mix.

How To Improve Your Credit Score?

Pay Your Bills On Time

If you want to boost your credit score, you should pay your payments on time. Whether it's credit card bills or loan repayments, you have to make sure that all payments are paid on time.

Your payment history accounts for 35% of your credit score. It is reported that even one payment that is 30 days late can result in a 90 to 110-point decline for someone with a good credit score.

When the payment is delayed for more than 30 days, it significantly impacts your credit score. A late payment is reported to your credit report for seven years. After that, the influence on your overall score decreases over time, but that negative mark remains significant.

Lower Your Credit Utilization

Credit utilization is the second most crucial component in your credit score after payment history, as it accounts for 30% of your credit score.

Credit utilization is the ratio of the amount of debt outstanding on your revolving credit sources, such as credit cards or home equity loans, in relation to your available credit.

The credit reporting companies do not have your income information. So, they calculate your credit usage instead of the debt-to-income ratio.

Suppose you have a credit card limit of $50,000, and you owe $5,000. Then you have a utilization ratio of 10%.

It is generally advised to maintain your credit usage below 30%. However, those with the highest credit scores often have a utilization rate of 10% or less.

Another strategy to lower your credit utilization is to increase your credit limit but make sure your balance remains the same.

Use Your Credit Cards Responsibly.

Irresponsible use of credit cards can negatively impact your credit score and budget. However, when used appropriately, a credit card may be one of the quickest methods to boost your credit score because it affects the essential part of your score.

Signing up for a credit card and paying on time every month helps you maintain a good payment history. Then, you can generate a low usage ratio by reducing card expenditures to a minimum.

Credit cards also have a favorable influence on your credit mix and new account aspects. This way, you'll be able to maintain your credit history and improve your credit score quickly.

Limit Your New Credit And Hard Inquiries

When applying for new credit, the lender requests to review your credit report and history, known as a hard inquiry.

Hard inquiries can harm your credit score. For example, applications for a new credit card, a mortgage, an auto loan, or some other type of new credit are hard inquiries.

The occasional hard inquiries are unlikely to have much of an impact. However, many of them in a short period of time can harm your credit score.

Banks may misinterpret that you require new funds because you are experiencing financial difficulties, making you a higher-risk client.

Therefore, avoid applying for new credit and hard inquiries for a while if you're trying to improve your credit score.

Consider Debt Consolidation

Debt consolidation is a strategy of borrowing a new loan to pay off all the outstanding debt and liabilities.

If you have much debt, it might be good to get a debt consolidation loan from a bank and pay them off all at once.

Then you'll only have one payment to make, and if you can get a lower interest rate on that loan, you'll be able to pay off your debt faster. This can help your credit utilization ratio and boost your credit score.

Similarly, you can pay off balances of multiple credit cards with a balance transfer credit card. Such cards frequently have a promotional period during which they charge 0% interest on your balance. However, be wary of balance transfer fees, which can range from 3% to 5%.

Use Credit Monitoring Services

If you plan to apply for a loan or improve your credit score, opting for a credit monitoring service is a must.

Credit monitoring services provide an easy way to track the progression of your credit score over time. These services monitor your credit report for changes in your credit history that can significantly impact your credit score.

The primary benefit of credit monitoring is that it helps prevent identity theft and fraud. For example, if someone opens a credit card account in your name, the credit monitoring service will notify you about it, and you can report it to the police for fraud and identity theft.

Conclusion

A credit score indicates your creditworthiness, and a good credit score has several financial benefits. If you are looking to borrow loans, the first step is to improve your credit score to get your loan approved and get the best financial deal.

If you have a bad credit score, it takes some time to improve your credit score but starting sooner is best than regretting later. Even if you have a good credit score now, it's essential to maintain consistency, as one wrong step can decrease your credit score significantly.

Thus, it is imperative to frequently monitor your credit score and improve it to make it easy for you to get the best financial deals.

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